‘You’ve got a massive tax bill? Lucky you!’ said no one, ever.
Financial planning has always been focused on making sure that as much as possible of your hard-earned money stays in your pocket, rather than the taxman’s. What’s the standard advice for most people? Use all your tax allowances, and plan ahead to make sure your income in retirement is as tax-efficient as is achievable. With good planning you can double, or even treble, the amount of income before tax needs to be paid on it. All very sensible and sound advice.
However, the reducing allowances for pension savings are making this strategy increasingly difficult to follow. The more complicated pension legislation gets, the more knots people tie themselves in.
For those in their 40s, with pension savings of around £500,000 already, investment growth alone could mean you exceed the current standard lifetime allowance. If so, it makes sense to stop pension contributions, doesn’t it? Especially for those fortunate enough to have an employer that would convert their pension contributions into extra salary instead. Perhaps not though.
Some high earners could end up paying more tax now than they would save later, particularly if an increase in salary meant they lose their personal allowance.
What if you have already stopped making pension contributions, perhaps because you have one of the various forms of protection? Are you aiming to get to the limit and then move it all into cash? Or are you happy to continue to let it grow beyond the limit? Your answer may depend on whether you are happy to accept the risk that the value of your fund might fall below the lifetime allowance again. If you are solely trying to ensure you don’t pay the tax – why? You are essentially paying less tax by having less money; it just doesn’t make any sense.
Let’s say a fund value grew beyond the lifetime allowance by another £100,000. Even after the 55% tax charge you would still have an extra £45,000. Had you moved the money into cash, the value would have been eroded by inflation.
I’m not suggesting that we should just start ignoring the hefty penalties and tax charges that can apply when one goes over the tax-efficient pensions savings limits. However, when dealing with the complex area of pensions for high earners, we should remember that one size really doesn’t fit all. Sometimes a more unconventional approach could be wise. Providing you have the right advice, of course.
‘You’ve got a massive tax bill? Lucky you!’ – said me, now.